Sunday, September 14, 2014

Here comes another BIS report, and another stark warning by the central banks' central bank, the Bank of International Settlements, best known for selling gold at key inflection points, that not only are asset prices are at "elevated" levels but that market volatility remains "exceptionally subdued" thanks to ultra-loose central bank policies around the world. In other words: pervasive complacency boosting the asset bubble to unseen levels and masking the threat of systemic shocks.

"... it is hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments globally.... Despite the euphoria in financial markets, investment remains weak. Instead of adding to productive capacity, large firms prefer to buy back shares or engage in mergers and acquisitions.

As history reminds us, there is little appetite for taking the long-term view. Few are ready to curb financial booms that make everyone feel illusively richer. Or to hold back on quick fixes for output slowdowns, even if such measures threaten to add fuel to unsustainable financial booms. Or to address balance sheet problems head-on during a bust when seemingly easier policies are on offer. The temptation to go for shortcuts is simply too strong, even if these shortcuts lead nowhere in the end.

This follows a just as solemn warning back in June 2013, when it warned that the monetary Kool-aid party is coming to an end:

Can central banks now really do “whatever it takes”? As each day goes by, it seems less and less likely... Six years have passed since the eruption of the global financial crisis, yet robust, self-sustaining, well balanced growth still eludes the global economy. If there were an easy path to that goal, we would have found it by now.

Monetary stimulus alone cannot provide the answer because the roots of the problem are not monetary. Hence, central banks must manage a return to their stabilisation role, allowing others to do the hard but essential work of adjustment.

Many large corporations are using cheap bond funding to lengthen the duration of their liabilities instead of investing in new production capacity.

Continued low interest rates and unconventional policies have made it easy for the private sector to postpone deleveraging, easy for the government to finance deficits, and easy for the authorities to delay needed reforms in the real economy and in the financial system.

Overindebtedness is one of the major barriers on the path to growth after a financial crisis. Borrowing more year after year is not the cure...in some places it may be difficult to avoid an overall reduction in accommodation because some policies have clearly hit their limits.

Which brings us to today, and the just released latest quarterly reviews, whose topic is summarized by the title of the chart below:

In today's release, instead of discussing leverage, or asset levels, this time the BIS' take on the global asset bubble, the same one decried by Deutsche Bank last week, is by way of collapsing volatility: i.e., the #1 specialty of the VIX-selling team at Libery 33, where Kevin Henry is such an instrumental part. Some exceprts:

After the spell of volatility in early August, the search for yield – a dominant theme in financial markets since mid-2012 – returned in full force. Volatility fell back to exceptional lows across virtually all asset classes, and risk premia remained compressed. By fostering risk-taking and the search for yield, accommodative monetary policies thus continued to support elevated asset price valuations and exceptionally subdued volatility.

Here, in addition to pointing out the obvious, the BIS highlights something that everyone else has been scratching their heads over: how with a world on the edge of war the global markets are just shy of all time highs:

Increased geopolitical stress had surprisingly little effect on energy markets. In the spot market, oil prices actually fell by around 11% between end-June and early September (Graph 1, right-hand panel). Market expectations for oil demand were revised down, largely on disappointing growth in the euro area and Japan. Incoming data from China were mixed, with that country’s manufacturing PMI registering an 18-month high in July, but falling back in August. All in all, demand factors seemingly offset concerns over potential short-run supply disruptions.

So how does the BS explain this paradox? Simple: hopes for even more easing, this time from the ECB:

The spell of market volatility proved to be short-lived and financial markets resumed their rally soon afterwards. By early September, global equity markets had recouped their losses and credit risk spreads once again consolidated at close to historical lows. While geopolitical worries kept weighing on financial market developments, these were ultimately superseded by the anticipation of further monetary policy accommodation in the euro area, providing support for asset prices.

In other words, central banks are now perceived to be more powerful even that the threat of regional or not so regional war.

Yet the core BIS' warning this time is one about complacency, as Reuters notes: "There were several references in the report to the "extraordinarily" and "exceptionally" low levels of volatility, suggesting the BIS feels markets may be getting too complacent and therefore vulnerable - and therefore ill-equipped to a shock."

To summarize: the bank that supervises all central banks has first warned about new and disturbing all time highs in leverage, then a global asset bubble driven largely by companies investing in stock buybacks instead of growth, and now about widespread unsustainable complacency. Surely this reiteration of everything that Zero Hedge has been warning about for years should be sufficient to send the e-mini comfortable above 2000 as soon as futures are open for trading.